A partnership firm is another form of business organization. This form of partnership organization came into being because of the limitations of a single trade organization. As the business grew, so did the business. It became difficult for a sole trader to manage this growing business.
As the size of the business increased, the business required a large amount of capital and required managerial skills to run the growing business smoothly. A single trader alone couldn’t provide large amounts of capital and managerial expertise. A sole trader could not control all business transactions.
A business began to require more than one person to acquire large amounts of capital and managerial expertise. According to this need, many individuals came together and started doing business by forming a partnership organization.
Partnership Organization
In a partnership firm, two or more persons come together and form a partnership firm. The persons in a partnership firm are called partners. All partners in a partnership firm contribute capital to the business. Each partner assumes responsibility for the management of the business. It divides the work. Partners are the owners of the business.
All the shareholders share the profit or loss of the business. If the business is to expand; A partnership organization comes into being to meet the need for additional capital and management expertise. While running a business requires a large amount of capital, it also requires skilled management. A partnership firm is considered a suitable form of organization to start such a business.
Features of Partnership Organization
After studying various definitions of partnership organization we will discuss some important features of partnership organization.
Two or More Persons
Two or more persons join together in a partnership organization. A one-person firm cannot be called a partnership firm. To form a partnership firm there has to be an ‘agreement’ and at least two persons are required to agree. Ignorant persons cannot form a partnership firm. Because ignorant persons are not qualified to enter into contracts.
Number of Partners
As per the Indian Contract Act, there is no limit on the number of partners in a partnership firm. However, as per the Indian Companies Act, there is a limit of a maximum of 10 partners in the banking business and a maximum of 20 partners in other businesses.
Unlimited Liability
As in a sole proprietorship, the liability of partners in a partnership firm is unlimited. If it is time to wind up the partnership firm and the assets of the partnership firm are insufficient to pay the debts of the partnership firm, then the private assets of the partners are used.
That is, the debts of the partnership firm can be paid from the private assets of the partners. This shows that the liability of the partners in a partnership firm is not limited but unlimited.
Make a Profit
The purpose of the business by forming a partnership firm should be to earn profit. Organizations working in a charitable nature cannot be called partnership organizations. Because the purpose behind their establishment is not to make a profit. A partnership firm may incur losses. But the main objective must be to make a profit.
Agreement
A partnership is formed by an institution agreement. A written or oral agreement is entered into between the partners in a partnership firm. The agreement should preferably be in writing. Because the written agreement can be used as evidence or reference in case of future disputes.
Agent and Owner Relationship
Partners in a partnership firm are simultaneously owners and directors. Partners transact on behalf of other partners. These transactions are binding on all other partners. A partner is both an agent and an owner in a transaction.
Business Existence
A partnership firm can be formed only to carry on business. The term business is used broadly. This includes trade, industry, etc. Activities such as production, distribution, service, etc., are expected from a business. It is for these activities that partnership organizations are formed. A partnership firm is not formed for charitable purposes.
Credibility
All partners in a partnership organization must have trust in each other. Each partner will benefit from the transaction. Transactions should be done in this way. It is necessary to present all the true information of the transaction to the other partners. If one partner mistrusts the other, the organization is unlikely to survive for long.
Limitation on Transfer of Shares
Unlike the shareholders of a joint stock company (company), the partners of a partnership cannot easily transfer their shares. If a partner of a partnership firm wants to transfer the shares, permission of the firm is required.
Transfer of shares can be done only if the partnership body permits the transfer of shares, otherwise not. That is, there are restrictions on the transfer of parts of a partnership firm.
Types of Partners
As we have seen in the discussion so far, a partnership firm consists of two or more partners. Not all partners in a partnership firm are actively involved in the business. Some partners run their independent businesses, while some partners actively participate in the business of the partner organization. There are many types of partners. Some of the major types can be mentioned as follows.
Active Partner
This partner is called the working partner. This partner actively participates in the day-to-day operations of the business. This partner works in any position in the business organization. For example, controller, manager, consultant, organizer, etc.
Inactive Partner
This partner is called a secret partner. This partner does not participate in the day-to-day operations of the business of the partnership firm. This partner provides his share of the capital required for the business. This partner is fully responsible for the profits of the business.
This partner is probably unknown to persons outside the business. Individuals who have money to invest. But there is no time to focus on daily activities. Such persons prefer to be passive partners.
Ignorance Partner
According to the Indian Contract Act, an ignorant person is incapable of ‘contracting’. So such a person is not eligible to be a partner. Yet an ignorant person can be admitted to a partnership firm as a partner for the benefit of the partnership firm with the consent of all the partners.
An ignorant partner provides capital to a partnership firm. Profits from the business are given to the ignorant partner. However, the ignorant partner is not liable for the loss in the business. The private property of an ignorant partner cannot be used to pay debts arising from the business.
Partners in Profits
This partner provides capital to the business. Does not participate in the management of the business. This partner only shares in the profits of the business. But if the business incurs a loss, the partner does not bear the share of the loss. The reputation and capital of such partners are utilized in the partnership organization.
Nominee Partner
This partner neither provides capital to the business nor participates in the management of the business. The partnership firm only uses the name of this partner. Only eminent persons in the business sector are used as nominee partners.
These nominal partners do not share in the profits and losses of the organization. Named partners allow the use of their reputation for the organization’s business. The reputation of the nominal shareholders is used to generate credit for the business.
Virtual Partner
A person who shows that he is a partner by his dealings or conduct while not being a partner of a partnership firm is called a virtual partner. If a person transacts with a partnership firm under the assumption that a virtual partner is a partner, such transaction is held liable to the virtual partner.
Partnership Firm-Registration
In England, partnership firms are required by law to register. In India, however, registration of partnership firms is not mandatory. Although registration is not compulsory for partnership firms in India, those firms are registered. Such partnership organizations have many advantages.
Of course, unregistered organizations are deprived of these benefits, so even though registration is not mandatory, partnership organizations in India prefer to register the organization. Even after registering a partnership firm, that partnership firm does not acquire a separate legal entity like a joint stock company.
That is, the partnership firm does not get an independent existence from the partners.
A registered partnership firm can sue in court for its rights against a third-party body or person. However, an unregistered organization cannot appeal to the court. Lenders of a partnership firm can file a claim in court against the partnership firm. Partners in a registered partnership firm can file a suit in court against each other or a third person.
That is, the registered partnership firm and the partners get judicial benefits. These benefits are not available to unregistered partnership firms and partners in that firm. So even though registering a partnership firm is not mandatory by law, it is still beneficial to register a partnership firm.
Advantages of partnership organization type of organization
The sole trader form of organization is advantageous for running a small-scale business. A partnership firm is a form of organization suitable for medium-sized businesses. Because a medium-sized business requires personal attention from the businessman. Some important advantages of partnership organization type of organization can be mentioned as follows.
Easy Installation
Setting up a partnership firm is easy. Legal complexities to be met for setting up a joint venture company. It is not required while setting up a partnership firm. No legal documents need to be completed to form a partnership firm.
Only a written or oral agreement can be used to form a partnership firm. Registration of a partnership firm is also optional. This shows that setting up a partnership firm is easy and less expensive.
Prompt Decision-Making Process
All partners in a partnership organization meet or meet frequently for work. So if a decision has to be taken on a matter, that decision is taken immediately. There is no delay in decision-making as in a joint stock company. A quick decision-making process allows the business to take advantage of the opportunities that arise.
Privacy
Privacy is very important in small and medium-sized businesses. A joint stock company has to publish a balance sheet, profit and loss statement, and balance sheet at the end of every financial year. Therefore, competitors are aware of the financial situation of their transactions.
However, the partnership body is not legally bound to publish such annual reports. So the partnership organization can maintain confidentiality of transactions and financial situation.
Credit Creation
A partnership firm has several partners. All these partners may have personal ties with various capital-providing institutions. So all the partners can build a large amount of credit together. All the partners can collectively provide the assets that the financial institutions ask to pledge as security. This increases the market credit of the partnership firm.
Control
The partners in a partnership firm manage the business themselves. So they keep an eye on all business transactions. This results in employee control and less loss of goods. Because partners have a direct relationship with employees, partners can encourage employees to increase productivity and, in turn, output.
Expansion and Development
Since there are many partners in a partnership firm, they can easily raise the capital required for the business firm. Similarly, it can provide skilled management to manage complex transactions.
A sole trader faces many limitations in providing both these aspects. However, partnership organizations can provide both. Therefore, the business of a partnership organization has a lot of scope for expansion and development.
The direct relationship between labor and wages
The objective behind setting up a partnership firm is to earn profit. All partners strive to achieve this objective. For this, attention is paid to how to produce more at less cost. The more attentively the partners work in the business, the more the partners are rewarded in the form of profits. That is, there is a direct relationship between labor and remuneration. This increases the profit margin.
Protection of Minority Interests
All decisions in a partnership organization are taken in the presence of all the partners. These decisions are passed by majority vote. If a decision is opposed by a partner and the decision is passed by a majority, the partner who is opposed to the decision may seek dissolution of the partnership organization. That is, the interest of the minority is protected in the partnership organization.
Managerial Knowledge/Skills
A partnership firm has more number of partners. Each partner gets an opportunity to work according to his knowledge and interest. Management of different departments is entrusted to different partners. Hence the knowledge and expertise of the partners can be utilized for the expansion of the business. The business benefits greatly as many tasks are delegated to different partners.
Flexibility in Operations
Unlike a joint stock company, there are no legal restrictions on the business of a partnership organization. A partnership body does not need to seek permission from the government even if it wants to make major changes in its current form of business. Objectives of the organization, number of members, capital, proportion of profit sharing, etc. can be easily changed according to the needs of the business organization. Thus flexibility in operations increases business efficiency and consequently increases profits.
Risk Division
In a sole trader type of organization, all the losses incurred by the business are borne by the sole trader alone. However, in a partnership organization, each risk is divided among several partners.
As risk is shared, all partners are always ready to expand the business. Because even if there is some risk from expanding the business, it will be shared among all the partners.
Easy to Dissolve
Setting up a partnership firm is as simple as that. Also, the dissolution of a partnership firm is easy. If one of the partners in the partnership becomes insane, insolvent, or dead, the partnership is dissolved.
Partnership Organization Limitations / Disadvantages of this type of organization
It is advantageous to do business by forming a partnership organization as compared to a sole proprietorship type. Accordingly, we have studied the advantages of partnership organization. Today’s business is very complex and competitive.
Due to this, the partnership organization also faced some limitations in doing business and some disadvantages arose from it. A brief discussion of these limitations/disadvantages follows-
Lack of Stability
The existence of a partnership firm is volatile. If a partner in a partnership becomes insane, insolvent, or dead, the partnership is dissolved. If a partner does not agree with the decision of the partnership firm, that partner can demand the dissolution of the partnership firm by showing no confidence.
That is, the existence of a partnership organization is unstable and of short duration. If such an institution suddenly closes down, the people of the society are inconvenienced. Similarly, the employees working in that organization become unemployed.
Unlimited liability
In a partnership firm, the responsibility of each partner is unlimited. If the partnership firm has to be dissolved for some reason and the assets of the firm are insufficient to pay the debts of the partnership firm, then the private property of the partners is used to pay the debts. That is, partners not only invest but also assume unlimited liability.
If one partner commits a mistake, all the other partners have to accept the responsibility. Hence, wealthy individuals probably do not invest in partnership firms. Therefore, there are limitations on the development of partnership organizations.
Due to unlimited liability, the partners hesitate to make bold decisions, which in turn adversely affects the expansion, and development of the partnership organization.
Less Financial Resources
Compared to a joint-stock company, a partnership organization has much more restrictions on raising capital. In a partnership business, 20 partners is the maximum number. Considering the pervasive nature of modern business. The ability of partners to provide capital is reduced.
Another important factor is that wealthy individuals are not eager to enter into a partnership organization because of the unlimited liability. Due to all these reasons a partnership firm cannot raise a large amount of capital.
Disbelief
A partnership firm works on the mutual trust of the partners. When a partnership firm is formed, all the partners trust each other. But as the partnership firm matures, all the partners come to know each other’s true nature. Then there are differences between the partners. The partners start distrusting each other and that leads to the dissolution of the partnership.
Limitation on Transfer of Shares
Transfer of shares of the joint stock company is easy. If a partner in a partnership firm wants to transfer his share, he has to obtain the consent of all the partners. Part/share cannot be transferred unless other partners consent. That is, there are restrictions on the transfer of part/share of a partnership firm.
Mistrust of Society
A partnership firm does not have to publish financial statements at the end of the financial year. That means all the transactions of the partnership organization remain secret. People are not aware of the business and financial situation of the partnership organization. People think that partnership firms make huge profits by exploiting customers. So society does not trust the partnership organization.
No Separate Legal Entity
The law has not given independent existence to the partnership body. Partnership firms and partners cannot be separated. A partnership has to be wound up if a partner becomes insane, insolvent, or dead.
That is, the existence of a partnership firm is entirely dependent on the partner. Due to this, it is not possible to predict when the partnership firm will be closed. So people are not very keen to invest capital in partnership firms.
Utility of Partnership Organization Type of Organization
Due to several limitations of the sole trader form of organization, the partnership form of organization came into existence. As production began to be heavily mechanized, every industry required a large amount of capital as well as skillful management. A single trading organization could not meet these requirements. Hence partnership organizations were formed and they took up this responsibility.
Although partnership organization has many limitations, it is very useful for medium-sized businesses. A partnership firm can raise capital required by a small or medium-sized business. Small or medium-sized businesses have limited product markets. Direct observation of work is important in a business of this size.
Because in partnership business there is a direct relation between work and remuneration. It means that after doing a lot of work, it can also get a lot of rewards. The partnership form of organization is useful for small and medium-sized businesses. Some businesses require direct contact with customers.
For example, lawyer’s profession, doctor’s profession, etc. Similarly, retail businesses also require direct contact with customers. It is convenient to do such business by setting up a partnership firm.
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